Understanding Alternative Investments

Alternative investments are those that fall outside the conventional investments types such as publicly traded stocks, bonds, and cash. The terms “traditional” and “alternative” should not be taken to imply that alternative investments are necessarily uncommon or are relatively recent additions to the investments universe. Some alternative investments actually date back further than other kinds. For example, assets such as real estate and commodities which are arguably two of the oldest investment classes fall under the umbrella of alternative investments.

They also include non-traditional approaches to investing using special investment vehicles (SIVs) such as private equity funds, hedge funds and exchange-traded funds (ETFs). SIVs enable investors to invest indirectly in assets. These vehicles collect money from many investors and pool it into a fund, which is then used to make investments and is overseen by an investment manager who makes decisions on behalf of the fund.

Compared to traditional investments, alternative ones are illiquid. This means that they cannot be converted to cash easily. They also have a low correlation of returns compared to those of traditional investments. This means that the market performance of traditional investments and alternative investments are independent of each other. Therefore, the inclusion of alternative investments in a portfolio can reduce its risk. Alternative investments face fewer regulations and have less transparency than traditional ones. They have limited data, which is not publicly available and also have unique legal and tax considerations.

The most pervasive alternative investments today are private equity and real estate. However, there are other, more specialized types, which also offer considerable returns. They include hedge funds, commodities, and infrastructure.